Mega-Pensions Claim GIPS Compliance Adds To Their Integrity And Transparency
A handful of the largest U.S. public pensions, such as CalPERS and STRS Ohio, facing increased public scrutiny claim that their compliance with voluntary standards developed for the money management industry—the Global Investment Performance Standards—enhances their integrity and transparency. Pension stakeholders should not be fooled.
In 2018, California Public Employees’ Retirement System (CalPERS), the largest defined-benefit public pension in the United States and the seventh largest worldwide, announced to the world its adoption of the Global Investment Performance Standards (GIPS) administered by CFA Institute.
CFA Institute proudly proclaimed, “By adopting the GIPS standards, CalPERS has displayed ethical leadership in the public pension industry by adopting the highest performance standards often required of the investment managers they hire (emphasis added).”
Note use of the word “often.” We’ll get back to that later.
CalPERS was likewise effusive.
“The GIPS standards allow firms to demonstrate that investment performance reporting meets globally accepted ethical best practices,” said Robert Paterson, Investment Manager at CalPERS. “As an asset owner, adopting the GIPS standards indicates our commitment to use the highest rigorous performance calculation and presentation standards in our reporting. The GIPS standards are a critical part of our commitment to integrity, transparency, and the interests of our beneficiaries.”
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The $90-billion-plus State Teachers Retirement System of Ohio similarly boasts: “We are currently one of only five U.S. pension plans that comply with these (GIPS) standards and have done so each year since 2006 as verified by an independent third-party, ACA Compliance Group. ACA completed rigorous testing and validation of the STRS Ohio total fund performance calculation inputs, resulting return and reporting and shared that STRS Ohio complies with the industry’s most stringent reporting practices (emphasis added).”
When public pensions openly congratulate themselves on their commitment to integrity and transparency, stakeholders need to be on guard.
What’s really going on here?
Introduced in 1999, the GIPS standards are universal, voluntary standards based on the fundamental principles of full disclosure and fair representation of investment performance. The GIPS standards are administered globally by CFA Institute and have been adopted by 1,700+ firms in more than 47 markets around the world, including some or all of the assets of the 24 of the top 25 asset management firms. That’s all fine and good.
CalPERS and STRS Ohio are two of only a handful of pensions to comply with GIPS standards. While many traditional investment managers secure GIPS compliance as a marketing tool, it is extremely rare (as well as problematic, in my opinion) for asset owners to incorporate GIPS principles in their own performance reporting to oversight boards, governing bodies and plan beneficiaries.
It has been noted that with increased public scrutiny of some asset owners—notably our nation’s severely underfunded, oft-mismanaged public pensions—GIPS compliance verification may be reassuring to stakeholders that the asset owner is following universal standards and best practices related to performance calculation.
That is, GIPS compliance may present some perceived public relations advantage to a state or local government pension under intense scrutiny.
To be clear, GIPS standards are voluntary asset management industry standards—standards which the industry agrees are “best practice” or acceptable. Whether GIPS standards are “best practice” or acceptable for retirement plan fiduciaries is an entirely different matter. That is, standards which the asset management industry is comfortable voluntarily adopting will almost certainly fail to be rigorous enough to meet the heightened standards applicable to fiduciaries charged with safeguarding retirement plan assets, in my opinion.
For example, public pensions increasingly are investing in opaque and illiquid real estate and other alternative funds. These investments involve substantial uncertainty regarding the value of such assets. While industry and GIPS standards permit these managers to unilaterally, subjectively value these assets they manage, such valuations cannot be considered credible by asset owners. After all, the managers are subject to a profound conflict of interest in establishing portfolio values for illiquid assets since they are compensated on the value of those assets through asset-based fees.
Thus, it is potentially misleading for public pensions which hold significant alternative investments (30% or more) to proudly state they have completed rigorous testing and validation of the total fund performance calculation inputs, resulting return and reporting and comply with the industry’s most stringent reporting practices. At a minimum, it is inaccurate to state that there has been “rigorous testing and validation” of the substantial real estate and alternative investment values. Whether public pensions or the real estate and alternative managers comply with voluntary asset management industry reporting practices which permit conflicted manager valuations is irrelevant—that’s not helpful to pension stakeholders.
But GIPS compliance is not the norm for alternative investment managers. As Justin Guthrie, Head of Performance Services at ACA Compliance Group was recently quoted saying:
“When it comes to traditional fixed income and equity mandates, nearly 80 percent of firms are GIPS-compliant. But, in sharp contrast, that statistic for alternative asset managers is less than 5 percent. In an age where institutional investors demand increased transparency across asset classes, I believe private equity firms, hedge funds and the real estate investment industry will find themselves changing their tune around voluntary compliance ahead of the updated 2020 GIPS standards coming in effect. We’ve seen first-hand from our client base that institutional investors are demanding GIPS compliance as a part of the RFP and overall due diligence process from alternative managers, which is precisely why the GIPS executive committee has been working hard to reorient the standards to accommodate a wide array of asset classes.
The world of private equity would particularly benefit from the broad adoption of the GIPS standards, as the industry faces a lack of standardized methodologies and consistency for the presentation of IRR results. There has been much concern around lines of credit and how private equity firms disclose performance results, including differences in the MOIC calculation as well as treatment of affiliated capital- the 2020 GIPS standards provide a framework for consistency, and prevent the comparison of apples to oranges when it comes to reporting results to investors.”
Guthrie’s above statements indicate that GIPS compliance verification is almost exclusively reserved to traditional asset managers. Few alternative asset managers (less than 5 percent, says Guthrie), and even fewer still pensions (only 5, says STRS Ohio), seek GIPS compliance verification services.
Based upon statements by ACA’s GIPS compliance experts that less than 5 percent of alternatives managers are GIPS compliant, it seems likely that most of CalPERS and STRS’ hundreds of alternative investment funds—handling tens of billions in retirement plan assets—are not GIPS compliant.
Further, my research indicates there is no reason to believe GIPS compliant pensions (which are increasingly relying upon alternative investments) are demanding, or the alternative investment managers are themselves voluntarily embracing GIPS compliance standards. That’s not happening. (There has been no response to my STRS Ohio public records request for documents related to alternative manager GIPS compliance; CalPERS has not responded to my questions regarding whether all of its alternative managers are required to be GIPS compliant.)
While GIPS compliance may assist managers in their marketing, it is not at all clear that GIPS compliance verification for pensions which invest a third or more of their assets in alternatives investments (which are generally not GIPS compliant) provides any meaningful benefit to stakeholders, in my opinion. On the other hand, the risk that GIPS compliance representations may be mischaracterized by severely underfunded public pensions subject to increasing public scrutiny, or misunderstood by their stakeholders seems very real.